Bearish Wheat Presents High-Odds Playing Field for Call Sellers

Bearish Wheat Presents High-Odds Playing Field for Call Sellers
Jan

23

2018

Bearish Wheat Presents High-Odds Playing Field for Call Sellers

Record Global Ending Stocks Make Out of the Money Call Strikes look Expensive – Despite Volatility

While selling options on commodities contracts may sound like an exotic and/or glamorous investment strategy, in reality it’s more show up for work and follow a formula.

The Formula is called FUDOM* and its steps are simple:

  1. Find a Market with Clear Fundamentals – Bullish or Bearish
  2. Sell Deep out of the Money options against those fundamentals
  3. Force the Market to Make a huge move against those fundamentals during a certain time period – if it can’t do it, you take the premium home.

(*To learn more about the FUDOM method of selling options, visit www.OptionSellers.com/FUDOM )

If it was a football play, it would be the fullback up the middle for 5 yards.

Over and over and over again. But executing those types of plays continually and safely throughout the year can pay big dividends at years end.

You don’t have to find the perfect opportunity. You don’t have to scan and search and filter for “overvalued” or “undervalued” markets. You don’t have to figure out something “nobody else knows.” Simply take the information already available and apply a high odds approach to it.

With those criteria in mind, our mid-market update presents to you this month, the Wheat market.

The Bear in Wheat

Wheat is a commodity whose fundamentals appear decidedly bearish. These fundamentals will likely be a burden on price for much of 2018, making wheat a prime candidate for call sellers. What are these fundamentals? The 3 with the biggest impact on price are covered below.

Top 3 Factors Affecting Wheat Price in 2018

 

1. Global Ending Stocks are Highest in History:
Due to bumper crops across much of the wheat producing world (thank rapidly improving genetically modified crops), global ending stocks are expected to balloon to 268.02 million metric tons in 2018 – the highest in recorded history. Global stocks to usage will also hit a staggering 36.1% in 2018 – also a new record.

GRAPH:World Weat - Ending Stocks vs Stocks/Usage Ratio

2017/18 will show the highest World Wheat Ending Stocks in History


2. US Wheat Ending Stocks at Second Highest Level on Record:
While down slightly from last year’s record numbers, US wheat ending stocks will still record second highest levels on record at 989 million bushels. While not a record, a 2017/18 stocks to usage figure of 47.4% reflects extremely high supplies and should be a burden to prices throughout the year.

(For our video seminar on the importance of ending stocks and stocks to usage numbers in grain price forecasting, visit https://www.optionsellers.com/agriculture )

GRAPH:US All Wheat Ending Stocks vs Stocks/Usage Ratio

2018 is expected to show the 2nd highest supply on record for US wheat and a burdensome stocks to usage number.


3. Seasonal Fundamentals are Weak:

GRAPH:Sep Wheat(CBOT) 10 Year Seasonal(8-17)

Wheat prices have historically tended to weaken through the US Spring planting season.


Unlike it’s cousins, corn and soybeans, wheat prices seldom benefit from the planting season price anxiety often seen in the US Springtime. Why? Because almost ¾ of the US wheat crop is winter wheat which is planted in the fall. Therefore, when traders and farmers are wringing their hands in March and April about weather conditions and how fast or slow their corn and soybean crops are getting planted – 75% of the wheat crop is already in the ground. Thus, the market tends to take its price cues from the newly harvested supplies leaving the shores of such exporters as Australia and South America. Historically, this has kept pressure on wheat prices during the US Spring.

Conclusion and Strategy

The combination of massive US and Global wheat supplies has kept wheat prices under pressure in the second half of 2017. The problem for wheat is, these fundamentals are unlikely to change anytime soon. It takes awhile to work through that much of a supply backlog. Further confounding the wheat bulls is the upcoming seasonal tendency for weaker wheat prices in the Spring.

December 2018 Wheat

GRAPH:December 2018 Wheat


Selling the December 6.00 Calls in Wheat


Does this mean that wheat prices can’t rally? Of course not. Markets can rally for a variety of reasons – often in the face of contradictory fundamentals. What it does mean is that a substantial, sustained rally is unlikely. The burdensome supply outlook will likely mean heavy commercial selling coming in to stifle any technical rallies .

We’ll be watching the wheat market for appropriate times and strike levels to sell calls for our managed accounts this month. Self directed investors can look to sell the December Wheat 6.00 calls on rallies. Look to take premium of at least $450 – $500 per option. Margin requirements are approximately $1,100 per option.

While volatility levels in wheat options have been subpar, that hasn’t mattered for call sellers. Clear, long standing fundamentals can trump volatility for months or even years at a time. If you’re an option seller, don’t overlook taking wheat call premium simply because its volatility numbers don’t show calls to be “overpriced.” If the fundamentals can’t take the price there, the option is worth 0. That would make any premium at all overpriced.

Have a great month of premium collection and we’ll be updating other markets in our February newsletter.

Regards,

James

For more information on managed commodity option selling portfolios with James Cordier and OptionSellers.com, visit www.OptionSellers.com/Discovery to request a Free Investor Information Pack. (Recommended Investment US $1 MM)

  1. First, I want to say thank you so much for sharing this with us. I’m seriously considering opening an account with your company. As a starter, what I need to do first is do some due diligence. The first thing that came to mind was that if the option strategy is successful why isn’t there huge ball of money that’s desperately seeking income rolling into the option selling scene? Is there any fundamental reasons or will it eventually find its way in going forward? Thank you for your insights.

    • Michael Gross Says:
      February 15, 2018 at 4:17 pm

      Tom,

      Great question to which I can only speculate on answers. But here goes:

      1. The volume and open interest in futures options is more than adequate for individual traders and moderate (or even larger) sized CTAs. However, its not the type of market that provides the legroom for $100 Billion Hedge funds. Thus, they don’t get the media coverage and thus, interest level from the general public.

      2. Much for reason #1, there are not as many specialist and thus, not as many books or educational materials available to investors on the strategy or asset class.

      3. There are as many ways to sell futures options as there are to trade stocks. Some better than others. Its not a silver bullet. Success comes with years of study, work and experience. In a day when attention spans are lower and much trading is based on quick rules and you’re “good to go” (ie: buy this stock and watch it soar), a strategy that involves a little study and understanding tends to take back stage. We try to provide the materials for qualified investors to learn what they need to know about the strategy without necessarily needing to become experts to get involved.

      All of that being said, the public is really starting to catch on to the option selling strategy – especially in stocks. Commodities have traditionally been an asset class of more sophisticated, higher capitalized investors. But many of those stock option sellers will eventually migrate to commodities as well.

      Thanks for asking that and I hope I’ve answered your question.

      Regards,
      Michael

  2. Walter Leong Says:
    January 24, 2018 at 8:07 am

    Hello Optionsellers,

    Thank you for the insights in the Wheat market.

    I have been tracking some of the agricultural commodities and found that cotton prices have spiked in recent months.

    Do you have an opinion on this?

    • Michael Gross Says:
      January 30, 2018 at 3:26 pm

      Walter,

      You’re a step ahead of us. Cotton has a strong seasonal coming up and will be a feature next month.

      Regards,
      Michael Gross

  3. James,

    1 If you’re bearish why not buy puts?

    2 Selling the December 600 call only brings approximately 7.875 cents per bushel. Not very much.

    https://www.barchart.com/futures/quotes/ZWZ18/options?futuresOptionsView=split&moneyness=allRows

    • Michael Gross Says:
      January 30, 2018 at 3:33 pm

      Dear Paul,

      1. Buy puts? You must be new to this website. For the 101 reasons not to buy options, I suggest picking up a copy of our book or visiting our homepage. Secondly, as we say in the video, we do not necessarily know if prices are going to move lower or not. Only that they are unlikely to move substantially higher. As an option seller, you are not in the business of guessing market direction.

      2. 7.875 cents per bushel is almost $400 per option. Our target is $500-$600 per option. The next small rally should get us there. At a margin of about $1200 per option, thats a 50% return on equity if options expire worthless. Thats plenty enough for us.

      I do appreciate your feedback and hope our further videos are helpful to you.

      Regards,
      James

  4. Luis Moran Says:
    January 24, 2018 at 12:14 am

    Kindly clarify the long time margin investment cost VS the Premium received. what is a good ratio

    • Michael Gross Says:
      January 30, 2018 at 3:34 pm

      Luis,

      We typically target a 35-50% return per option.

      Sincerely,
      Michael

      • Michael, my average ROM is probably appx 28% to 40% but I also annualize it with a minimum acceptable annualization never to be below 50%. Of course, all of the technicals (seasonals, etc.) have to be favorable. Do you think the 28% ROM is an acceptable return if the technicals are favorable?????
        Thank you.

      • Michael Gross Says:
        February 7, 2018 at 3:29 pm

        Alan,

        While I think you can do better than (per trade) with minimum exchange margin requirements, I understand that is not always possible with many brokerages. Thus, yes, I think that is still an acceptable return by most any standard.

        Regards,
        Michael

  5. What is the cost to open a trading account with your firm?

    • Michael Gross Says:
      January 30, 2018 at 3:35 pm

      Frederico,

      Our minimum opening deposit is $250,000. However, on May 1, that is being raised to $500,000.

      Regards,
      Michael

  6. Scott Wallace Says:
    January 23, 2018 at 11:28 pm

    Do you think the potential damage to winter wheat this year is minimal? Also rumored dry weather is some areas.

    I agree 6 looks like a safe strike.

    • Michael Gross Says:
      January 30, 2018 at 3:38 pm

      Scott,

      At this point, there is only speculation that about weather damage to some of the winter wheat. But that is typical of any winter. Its early in the year and plenty of time ahead. At this point, we see no major reduction to the 2018 crop. But its a good idea to always be monitoring. Even with a moderate yield adjustment in 2018, we still feel the 6.00 strike would be safe.

      Regards,
      Michael

  7. Always love getting your newsletters. Hopefully as I build more wealth I will be able to comfortably open an account. Thanks again for what you do and how you do it.

  8. Alexander Martens Says:
    January 23, 2018 at 6:02 pm

    Thank you guys. Great Content.

    I looked for Credit Spread in July Contract. 500/550 Spread. But the Funds are that much Short right now coupled with weak Dollar. I am afraid of Short Covering. But also i see it as Opportunity, if short covering appers i will short that Market like crazy.

    Thanks!

    Best Regards
    Alexander Martens

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